Uphill Climb

Fight Against Illegal Currency Trading

Over the recent months, the government has undertaken several measures to wipe out the parallel exchange market. But none of the measures were effective in arresting the spread of black market transactions. The first step was spreading a false rumor that the government would adjust the exchange rate. In doing so, it managed to temporarily weaken the black market and narrow the gap between it, and the official exchange market to as low as five cents. This was short-lived though. Black market players, who saw that the government did not keep its word, started raising the exchange rates again. Frustrated by their actions, the government, in an unprecedented move, shut down businesses engaged in the informal exchange market. But that also didn’t work, as the gap between the parallel and official market widened by almost eight birr. EBR’s Samson Berhane investigates.

Girma Fisseha (name changed to protect his identity), a 27 year-old black market dealer, will never forget August 27 2018. The morning started normally, with business going on as usual in the area around the National Theatre, where he had worked for the past three years. Like any other day, he was calling to individuals passing by, asking whether they wanted to buy or sell hard currency.

Things changed after he went to a restaurant for lunch. In an operation that started around 1:00pm, police officers began shutting down more than 100 businesses including those operating around National Theatre; some of them run by friends of Girma. These businesses were allegedly involved in the foreign exchange black market.

Some of the business owners arrested including some of Girma’s friends while the rest, who were left holding huge sums of foreign and local currencies, began closely following the latest developments. Fearing they would be arrested, a few, including Girma, left the area immediately. “Although we always take precautions in every exchange we make, we never expected that many officers would encircle the area in no less than 30 minutes,” he told EBR.

The raid resulted in the government seizing a great amount of local and foreign currencies. Such administrative measures have weakened the exchange rate of foreign currency in the most famous black market areas in Addis. In initial days after the crackdown, the exchange rate on the black market decreased to around ETB 32 against the US dollar, from around ETB 35. However, this was short-lived.

A few weeks after the crackdown, things went back to normal. The shops that were closed for illegal currency trading reopened. Girma and his friends took advantage of the opportunity to go back to work. “Instead of discouraging the activities in the black market, the government’s actions made the problem worse,” argues Girma. “The gap between the official and parallel exchange rate widened.” Currently, a dollar is exchanged for as high as ETB34 in the black market.

Why Does the Black Market Persist? Although the reasons for its existence are not as obvious as they may seem, parallel markets are common in countries like Ethiopia, which follow managed floating exchange rate systems: excess demands for foreign currency are subject to legal restrictions, or to official price ceilings, according to a study by the International Monetary Fund (IMF). Typically, the parallel market is present in countries where the exchange rate is pegged by a central bank, and only banks and a few registered agents are allowed to engage in currency transactions. When purchases of foreign currencies by domestic agents are restricted and allowed on the basis of their essentiality for economic development, the exchange rate offered on the black market will rise above the official market. However, the existence of a parallel foreign exchange market can be partly explained by the existence of controls in the capital market and the existence of individuals and businesses operating in illicit commodities markets.

A lack of effective economic policies to control black market premiums and restrictions of exchange rates discourage individuals and businesses from using formal channels, according to a study by the IMF – which repeatedly suggested that the Ethiopian government should adopt a floating exchange rate regime. But, irrespective of the initial factors leading to its rise and expansion, the size of the parallel market in any country will depend on the range of transactions subject to exchange controls, as well as the extent to which these controls are imposed by the authorities.

In Ethiopia, the central bank does not have sufficient reserves or borrowing capacity to satisfy the demand for forex at the official exchange rate. Therefore, the parallel markets became well developed and organized, with an exchange rate higher than the official rate. In fact, based on an informal preliminary assessment by the central bank two years ago, a single shop is capable of providing hundreds of thousands in foreign currency at a time. Taking into account the large number of shops engaged in this activity, particularly in Addis Ababa, the National Bank of Ethiopia (NBE) estimates that millions of foreign currencies are transacted in the black market.

There have been a considerable number of recent arrests of people attempting to illegally smuggle foreign currency out of Ethiopia. Actually, Ethiopia loses more than three billion dollars annually because of capital flight, according to an estimation by a high level panel at the African Union in 2015. “The main culprit is trade mispricing. This is partly due to problems related to the customs system and severe shortages of foreign currency. The recent political instability has its own share in capital flight,” argues Abdulmenan Mohammed, a financial expert.

Amin Abdella, an economist and industry and trade coordinator at the Ethiopian Economics Association, on the other hand, says one of the root causes of the problem is the deficit in balance of payment. “This has always been a troubling issue for Ethiopia. The nation lags far behind in the international arena, mainly because of an underdeveloped manufacturing industries. The lack of infrastructure means that the nation’s foreign trade is insignificant as it exports considerably less compared to its imports.”

Ethiopia’s import bill is five times more than it export earnings. The situation has resulted in a widening trade deficit, putting a lot of pressure on the country’s economy. Coupled with dwindling financial capital and capital flight, it led to a USD14.7 billion deficit in the balance of payment last fiscal year. In 2008, the figure stood at USD6.1 billion, according to the National Bank.

This is mainly due to the fact that imports have not been substituted by local production, while the government’s export promotion policy hasn’t borne fruit. “The government’s inability to substitute imports means the problem will not be solved in the short-term,” says Amin.

Considering the reality on the ground, Amin admits that more than half of the items imported into Ethiopia, such as fuel, fertilizer and capital goods are not easily substitutable in the short term. Fuel and fertilizer account for one-quarter of the nation’s imports, whereas capital and consumer goods make up 40Pct and 31Pct of aggregate imports. Still, he thinks prioritization is vitally necessary. “Import substitution is the only choice left, but has been overlooked by the government so far.”

The profitability of the informal forex business is another push factor, according to black market operators. “I collect foreign currency from people coming from abroad for higher than the official exchange rate because I know their real value against the Birr will rise in the short term,” explains Elias Tessema, who owns a shop that sells household goods in Merkato.

For Fekiru W. Tinsae, Marketing and Communications Director at Wegagen Bank, however, overregulation is a major reason for the thriving black market in Ethiopia. “As regulations become stricter and tougher, people will be encouraged to get involved in the informal market beyond the watch of the government. In fact, there are almost no incentives for individuals and businesses to choose the formal exchange market.”

Fekiru’s argument holds water, as the government has made it extraordinarily difficult for individuals to legally obtain hard currency. Not only are there major restrictions on the amount one can acquire, but the complications of the process would push anyone to look towards the parallel market. Businesses, for instance, must wait for more than 18 months to open letters of credit (LC) and access foreign currency. On the other hand, individuals who want to travel abroad must provide their tickets and declare when, where and why they are travelling. Even after this, and after exhaustive procedures, one can still be denied foreign currency, or be given less than the amount needed to cover expenses.

The experiences of other countries reveal that controls on foreign currency emerge following the overvaluation of local currency, which is common when the supply fails to meet the demand. Controls are imposed to try and protect the government’s limited stock of foreign currency reserves, according to economists and financial experts EBR spoke to. Recent empirical analyses conducted by the World Bank, the IMF and others conclude that the Ethiopian economy has been suffering from an overvalued exchange rate. Until the end of last fiscal year, the real effective exchange rate of the Birr was estimated to be overvalued by 20Pct against dollar, even after the devaluation of the birr in October 2017 by 15Pct.

Be that as it may, economists also blame the growth in the money supply for the popularity of the black market in Ethiopia. “The rise in the money supply, which resulted from the rise in government expenditure, has helped the parallel market thrive,” stresses Amin, the economist.

Until the end of the last quarter of last fiscal year, the broad money supply stood at ETB740.6 billion, a 29.2Pct growth from the same period last year, according to the NBE’s latest report. The growth of the broad money supply was largely attributed by the central bank to the expansion in domestic credit and increase in net foreign assets.

Abdulmenan stresses that a massive growth in money supply induces greater demand for imported goods and services. “As a result, demand for foreign currencies in the formal market will soar. When the official market fails to supply enough foreign currencies, and there is an inconsistency between macroeconomic policies, foreign trade and the exchange rate regime, it creates an an environment that lets the parallel market thrive,” he argues. “The government is overwhelmingly focused on sustaining economic growth while side-lining other issues such as inflation and budget deficit as well as loose fiscal and monetary policies. These side-lined issues are also the major culprits for thriving black markets.”

Mission Impossible
The government has implemented various macroeconomic policies in an attempt to abolish the parallel foreign exchange market and create a unified exchange market. However, none of them have helped the country move towards the realization of a single (unified) forex market. The survival of the parallel market, even at a higher exchange rate than the official one, has made the situation more complicated and exposed the country to macroeconomic woes, according to economic analysts.

Last year, multiple consecutive measures were taken to weaken the parallel market. The first was the devaluation of birr by 15Pct against major baskets of currency, which proved ineffective. Although it was not as inflationary as previous devaluations, the government’s attempts to raise export earnings, which stood around three billion dollars, failed. “The trouble is that devaluation won’t improve export performance, as Ethiopia mainly relies on the export of limited agricultural commodities. As last year’s devaluation showed, the export performance is the same whereas the cost of imports soared,” says Abdulmenan.

A few months after the exchange rate adjustment, a new directive was enacted to prevent under-invoicing of imported items. Since most businesses get less forex than they require from commercial banks, they fulfill the rest by purchasing hard currency from the black market. However, importers under invoice the price of their commodities to match with the LC. The directive was intended to stop such practices.

The government also opened a window of opportunity for legal as well as illegible account holders to access foreign currency without waiting for the approval of LC, with the introduction of diaspora accounts, but to no avail.

Meanwhile, Prime Minister Abiy Ahmed (PhD), who took power in the midst of the foreign exchange crisis, continues taking administrative measures by shutting down businesses engaged in the parallel market. Although the gap between the two exchange markets reached historic lows soon after he took power, it didn’t last.

“Administrative measures are short term solutions. They drive participants into hiding for some time. As long as the black market is attractive in terms of returns, it will thrive,” says Abdulmenan. “Allowing more business people to have foreign currency bank accounts, and easing the path for funds to circulate is recommended.”

Abdulmenan also recommends making the exchange rate competitive by legalizing the sector, which will have the discretion to set its own rates, can be a solution. Amin, on the other hand, does not buy this idea. “Legalizing the parallel market will increase the capital flight, which has already reached at a critical stage. It will also widen the balance of payment deficit.”

7th Year • Nov.16 – Dec.15 2018 • No. 68